IMF Wraps Up 2024 Article IV Consultation in Tonga

Washington, DC: On November 6, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation ^[1] with the Kingdom of Tonga.

Tonga's economic activity has strengthened, bolstered by consistent remittance flows, continued tourism recovery, and robust construction activities. Despite a fall in agricultural output, GDP in FY2024 (July 2023 – June 2024) is estimated to have expanded at 1.8 percent. The potential for a stronger recovery has, however, been hindered by supply-side constraints including labor shortages.

Inflationary pressures have substantially eased. After peaking at 14.1 percent in September 2022, headline inflation has since been normalizing. Notwithstanding a spike in local food prices, headline inflation fell to 3 percent in July 2024, below the 5 percent reference rate of the National Reserve Bank of Tonga (NRBT), driven by a steady decline in core prices and a moderation of global goods and commodity prices.

The near-term baseline economic outlook remains favorable appropriately supported by expansionary fiscal and monetary policy. Real GDP growth is projected to accelerate to 2.4 percent in FY2025, mostly led by continued strength in domestic demand including large public investment projects and a rebound in agricultural output as the effects of El Nino dissipate. The medium-term growth prospects remain uneven, however. Tonga's long-term growth is projected at 1.2 percent, reflecting its exposure to increasingly frequent natural disasters, persistent loss of workers to emigration, and limited economies of scale due to geographical barriers. The balance of risks is, thus, tilted to the downside. A global slowdown could reduce tourism receipts and remittances while rising vulnerabilities in the banking sector, even though localized, pose a downside tail risk.

Executive Board Assessment ^[2]

Executive Directors agreed with the thrust of the staff appraisal. They welcomed the Tongan authorities' ongoing efforts to support the economic recovery following the volcanic eruption and secure donor financing for substantive infrastructure projects. While noting the firming up of the economy and the favorable near-term outlook, Directors concurred that medium-term growth prospects remain weak, reflecting economic fragility and important downside risks. Against this backdrop, they underscored the importance of steadfast policy implementation and reforms to pave the way for continued macroeconomic stability and sustained growth. They also highlighted the need for sustained financial support from the international community as well as capacity development from the IMF.

Directors noted that the current fiscal stance is appropriately supporting reconstruction and building resilience. Given the high risk of debt distress and sizable financing needs, they stressed that over the medium term, a credible fiscal consolidation, additional grant financing, and refraining from new non-concessional borrowing are essential to place debt on a downward trajectory while achieving Tonga's development goals. Directors recommended efforts to mobilize revenue, including streamlining tax exemptions and strengthening tax administration. They also called for enhancing public financial management and spending efficiency, containing the public sector wage bill, and adhering to the fiscal rule.

Directors concurred that the current monetary policy stance is appropriate, as inflation has stabilized below the central bank's reference rate. They agreed that tightening would be warranted should inflation pressures resurface. Directors noted that the forthcoming amendments to the central bank act constitute an opportunity to further strengthen the monetary policy framework in line with IMF recommendations. Noting localized vulnerabilities in the banking system, Directors encouraged the authorities to closely monitor credit risks and ensure adequate provisioning for loan losses. They recommended expanding supervisory and regulatory frameworks to cover non-bank financial institutions.

Directors agreed that structural reforms are essential to enhance resilience to climate change and natural disasters and to promote private sector development. They stressed that enhancing anti-corruption and governance frameworks is crucial to meet Tonga's development goals. In this context, Directors welcomed the appointment of the first anti-corruption commissioner and the authorities' commitment to continue strengthening the AML/CFT framework, which is needed to help reduce the risk of losing correspondent banking relationships. They encouraged the authorities to advance digitalization, boost financial inclusion, address supply-side constraints and reduce gender inequalities, and further enhance the quality and timeliness of macroeconomic statistics.

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm .